lululemon athletica inc. — Form 10-Q Summary
Reporting period: The filing covers the thirteen and thirty-nine weeks ended November 3, 2013, compared with October 28, 2012. Although the request metadata identifies “2012 Q3,” the supplied filing is the fiscal 2013 third-quarter Form 10-Q. Fiscal 2013 is a 52-week year ending February 2, 2014; fiscal 2012 was a 53-week year.
Business context
Lululemon designs and sells technical athletic apparel through corporate-owned stores, e-commerce, wholesale accounts, showrooms and outlets. At November 3, 2013, the company operated 247 corporate-owned stores: 166 in the United States, 53 in Canada, 25 in Australia and three in New Zealand, compared with 211 stores at February 3, 2013.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Change |
|---|---|---|---|
| Net revenue | $379.9 million | $316.5 million | +20% |
| Gross profit | $204.6 million | $175.3 million | +17% |
| Gross margin | 53.9% | 55.4% | -150 bps |
| Income from operations | $92.3 million | $80.6 million | +15% |
| Operating margin | 24.3% | 25.5% | -120 bps |
| Net income attributable to lululemon | $66.1 million | $57.3 million | +15% |
| Diluted EPS | $0.45 | $0.39 | +$0.06 |
For the first thirty-nine weeks, revenue was $1.070 billion, up 21%; gross profit was $561.3 million, up 15%; operating income was $237.2 million, up 6%; and net income attributable to lululemon was $169.9 million, up 5%. Gross margin declined to 52.4% from 55.2%, while operating margin declined to 22.2% from 25.3%. Diluted EPS increased to $1.16 from $1.11.
- Q3 corporate-owned store revenue increased 15% to $290.7 million; comparable-store sales increased 2%, or 5% excluding foreign currency effects.
- Q3 direct-to-consumer revenue increased 37% to $62.0 million and represented 16.3% of total revenue, compared with 14.3% in the prior-year quarter.
- First-nine-month direct-to-consumer revenue increased 39% to $165.3 million and represented 15.5% of revenue.
- Cash and cash equivalents were $600.7 million at November 3, 2013, compared with $590.2 million at February 3, 2013.
- Working capital excluding cash was $185.2 million. Total liabilities were $131.8 million and stockholders’ equity was $1.043 billion.
- Inventory was $206.2 million, up from $155.2 million at fiscal year-end, including a $26.7 million valuation provision.
- The company reported no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility. Letters of credit and guarantees totaled $1.0 million.
Cash flow and capital allocation
- Operating cash flow for the first nine months was $94.8 million, down from $113.2 million, primarily because of higher income-tax payments and working-capital investment.
- Capital expenditures were $71.9 million, substantially unchanged from $72.0 million in the prior-year period.
- Financing activities provided $8.7 million, compared with $11.9 million of cash used in the prior-year period, which included $26.0 million for the purchase of the remaining non-controlling interest in lululemon Australia.
- Cash increased by $10.6 million to $600.7 million after a $20.9 million unfavorable foreign-exchange effect.
- During the quarter, the company repurchased 22,582 shares under its announced program. Approximately 5.455 million shares remained available under the program at quarter-end.
Material changes versus the prior comparable period
- Revenue growth was driven by new stores, higher comparable-store sales and strong e-commerce traffic. The company opened 46 net new corporate-owned stores since the third quarter of fiscal 2012, including 39 in the United States.
- Gross margin deteriorated because of higher product costs, increased air freight, higher markdowns, product mix changes and inventory provisions.
- The company recorded a $17.5 million inventory provision related to the pull-back of women’s black luon pants that did not meet specifications. Management stated that the issue reduced revenue and increased costs during the first three quarters.
- SG&A increased 19% in Q3 and 23% year to date, reflecting store growth, higher wages, increased head-office staffing, strategic initiatives and expansion of the direct-to-consumer channel.
- Foreign-currency translation, particularly a stronger U.S. dollar against the Canadian dollar, negatively affected reported results. A 10% depreciation of the Canadian dollar versus the U.S. dollar would have reduced first-nine-month operating income by approximately $3.8 million based on the company’s sensitivity analysis.
Outlook, risks and unusual items
Management stated that cash from operations and available borrowings should be adequate to meet liquidity and capital-expenditure needs for at least the next 24 months. The filing does not provide a clear numerical revenue, earnings or margin guidance forecast. Management expects continued investment in e-commerce, information technology, stores, international expansion and community-based brand development.
- The business is seasonal, with a significant portion of operating profit historically generated in the fourth quarter holiday period; therefore, interim results are not necessarily indicative of full-year performance.
- Key operating risks include product-quality failures, reliance on third-party suppliers and manufacturers, raw-material and freight-cost inflation, inventory forecasting, consumer discretionary spending, competition, international expansion, foreign exchange and information-system disruptions.
- The company is defending shareholder derivative, securities class-action and books-and-records proceedings related principally to the March 2013 sheer luon product issue, executive succession disclosures and certain stock trades. Management believes the claims lack merit and stated that current proceedings are not expected to materially affect financial position, results or cash flows.
- Management reported that disclosure controls and procedures were effective as of November 3, 2013, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the $17.5 million luon-related inventory charge and related lost sales represent a substantially non-recurring event or signal continuing product-quality and supply-chain problems.
- Whether gross margin can recover from the 52.4% first-nine-month level as product costs, freight, markdowns and inventory provisions normalize.
- The sustainability of e-commerce growth and the profitability of continued store expansion, particularly in the United States and international markets.
- Inventory levels, aging and future markdown exposure following the increase to $206.2 million.
- Progress and potential financial exposure in the shareholder litigation and books-and-records proceedings.
- Foreign-exchange sensitivity, especially the effect of Canadian-dollar depreciation on reported revenue and operating income.
- Fourth-quarter seasonal execution, as a substantial portion of annual profit is historically generated during the holiday period.